Blogs & Comment

Segregated funds and index funds

Being mutual funds with capital-income guarantees, segregated funds have an appeal to older personsfor retirement and estate-planning purposes. So much so that Canadians owned about $140-billion worth of the funds last year, which is about one-quarter the size of mutual-fund assets (according to Toronto Starcolumnist Ellen Roseman).
It`s rather peculiar, though, that most segregated funds are based on actively managed mutual funds. They seem to be stuck in a time warp. The trend toward index funds and exchange-traded funds (ETFs) is well established in the realm of regular mutual funds but virtually absent in the realm of seg funds.
If seg funds were based on index funds and ETFs, their annual management expense ratios (MERs) would come down dramatically. It`s said the insurance features of seg funds add 0.5 to 1 percentage points to MERs, so a seg fund based on the iShares Canadian Large Cap 60 Index Fund ( XIU), for example, could cost as little as 0.7%. By comparison, MERs for seg funds are close to, and above, 3%.
It turns out ETF providers are eyeing this market. When I asked Som Seif, head of Claymore Investments in Canada, he responded: “Yes, seg funds on ETFs are possible. We think that it is an area of change to come and can help lower the costs of the seg industry. We are working with several players to try and introduce them.
One index-fund company, Oakville-based Pro-Financial Asset Management Inc., already offers seg funds based on index funds (which use the Research Affiliates Fundamental Indexing methodology). Vice president Preet Banerjee provides info on MERs.
Individual Pro-Financial seg funds have MERs ranging from 2.57% for Canadian equities to 3.1% for emerging markets. Pro Financial also has four portfolio funds, which range from 2.47% for the conservative portfolio to 2.63% for the aggressive portfolio.
These funds thus cost about the same as regular funds yet haveextra value inthe principal guarantee and death benefits. The portfolio funds come with the option of a guaranteed minimum withdrawal benefit (GMWB), which adds another 0.5% to 0.9% to MERs.
Seems like a good deal compared to what`s available. And whenever ETF-based seg funds hit the market,costs will get even lower, down to about the 0.7 to 1.5% range.